Does DuPont Have a Growth Catalyst?

October 28, 2002

By Heesun Wee After a quick look at recent earnings reports, investors may be tempted to scoop up shares of U.S. chemical giant DuPont (DD). On Oct. 23, it reported third-quarter earnings that jumped to nearly three times those of the same quarter a year ago, helped by strong sales in the housing and auto sectors. DuPont, which is a component of the Dow Jones industrial average, earned $469 million, or 47 cents a share, on revenues that dipped slightly to $5.5 billion, vs. the same quarter a year earlier, amid price pressure on chemicals and plastics.

Cautious investors, however, may want to wait a bit. DuPont's most recent good news is probably already reflected in its share price, which is up 17% since hitting a 52-week low of $35.02 in late September. It was trading around $41 as of Oct. 25. Many investors believe a further increase will be justified only after signs are clear that DuPont's latest reorganization and its new growth strategy are paying off. "With no innovative blockbuster products in more than a decade, DuPont has seen its premium valuation fall. It's now a chemical company looked upon mostly as a play on the economic cycle," notes Jeffrey Peck, an analyst who covers DuPont for Janney Montgomery Scott. He has a hold rating on the stock.

Certainly, there are reasons for optimism about the Wilmington (Del.)-based company. DuPont's soaring third-quarter profits came despite the rising price of crude oil, which has jumped roughly 40%, to around $30 a barrel, since the beginning of 2002. Fueled by the prospect of military action in Iraq, which could lead to supply disruptions, the oil-price hikes are already raising the cost of the feed stocks that DuPont uses to make many of its products.

BETTER BARGAIN? The strong third-quarter performance is evidence that DuPont, which is less of a pure chemical company than archrival Dow Chemical (DOW), is somewhat less vulnerable to cyclical swings in commodity prices than its competitor. Indeed, Dow saw third-quarter profits fall short of initial expectations.

By some measures, DuPont is still a better bargain than rival chemical companies. At its closing share price of $40.60 on Oct. 28, it's trading at around 21 times the Street's averaged EPS estimate of $1.98 for 2002. The shares are slightly more expensive than those of competitors, notes Richard O'Reilly, a chemicals-industry analyst for Standard & Poor's.

DuPont also has been doing better than rival outfits for some time. In 2001, it netted $4.3 billion, or $1.19 a share, on sales of $24.7 billion. By contrast, Dow reported a net loss of $385 million. Moreover, DuPont expects its margins to continue to improve, and it says it's aiming to achieve annual EPS gains of 10% on revenue growth of 6% over the next few years.

FIVE GROWTH PLATFORMS. Skeptics wonder if the current positive trends at DuPont have much to do with better operating fundamentals. Third-quarter profits got a major boost when Uncle Sam took a smaller bite than had been expected, adding 14 cents to per-share profits. "We're not seeing anything from the standpoint that business is getting better," says Maurice Austin, equity analyst and vice-president of Columbia Management Group, the asset management arm of Fleet Boston.

Many investors want evidence that DuPont's recent business reorganization will produce more hits and sustained growth. In February, DuPont realigned its businesses along five new growth platforms: electronic and communication technologies, performance materials, coatings and color technologies, agriculture and nutrition, and safety and protection (products and services related to building safety and security).

"Our new growth platforms, more tightly focused on markets and technologies, will enable faster execution and an improved capability for innovation, acquisitions, and value creation," said CEO Charles Holliday, Jr., in a prepared statement. DuPont executives were not available to comment for this story. As part of its reorganization, the stagnant textiles-and-interiors business has been separated into a wholly owned subsidiary, with management looking at several options, including an initial public offering. The ultimate goal is separation by the end of 2003.

LOOKING FOR BIG HITS. Under the new strategy, DuPont plans to improve productivity and look to scientific discoveries as catalysts for boosting performance, especially in faster-growing segments such as the safety and protection and electronic and communication businesses. The latter unit makes products including semiconductor fabrication-and-packaging materials, and slimmer, high-definition screens for TVs and PDAs. Despite the current downturn in the semiconductor industry, the latter could be a "blockbuster" for DuPont in 2004, says Vivek Tapuriah, an analyst with consultancy Frost & Sullivan.

DuPont could use some new-product hits. Some analysts gripe that it has been years since it has come up with a major home run on par with the stretch fabric Lycra, launched in 1962, and Kevlar, the bulletproof fiber used in body armor and developed in 1964. Yet, despite Holliday's increased emphasis on product innovation, research-and-development spending remained at $1.2 billion in 2002, virtually unchanged since 2000. DuPont has countered such criticism by pointing to successes like Stainmaster carpeting introduced in 1986 and a branded soy protein called Solae that came out in 2000.

Many investors also are taking a wait-and-see approach to DuPont's plan to boost growth through acquisitions. Two of its major moves in the last two decades didn't work out especially well: In 1981, DuPont bought the oil company Conoco for $8 billion in order to gain a secure source of petroleum feed stocks needed for its fiber and plastics operations. Then, in 1990, it formed a pharmaceutical joint venture with Merck (MRK), acquiring its partner's interest in the venture in 1998. In 1999, DuPont sold off its Conoco shares. A year ago, it completed a deal to sell its drug unit to Bristol-Myers Squibb (BMY) for $8 billion.

CASH STASH. The question now is whether DuPont's latest acquisitions will be more successful. In 1999 it paid $7.7 billion for seed company Hi-Bred International, strengthening its push into agriculture and nutrition. This year, it has entered into deals to purchase two midsize outfits as part of the strategy to boost its five growth platforms. The larger of the two, announced in July, is $408 million deal for Jackson (Miss.)-based ChemFirst (CEM), a supplier of specialty chemicals and materials to the semiconductor industry.

The acquisition, however, was cast into doubt when DuPont recently informed ChemFirst that it can't go through without further investigation of an explosion at a ChemFirst plant in Pascagoula, Miss. Analysts figure DuPont can easily find another, similar acquisition if the ChemFirst deal falls through. They also expect more such purchases to boost DuPont's electronics and safety businesses. And DuPont still has deep pockets: As of midyear, it listed about $3.1 billion from the sale of the drug unit in cash and cash equivalents on its balance sheet.

Some DuPont followers applaud the reorganization and the steady-as-you-go pace of change Holliday is setting. "They aren't biting off more than they can chew," says Frank Mitsch, who follows DuPont for Bear Stearns and recently upgraded his recommendation to outperform from attractive, also placing the stock on Bear Stearns' focus list. More wary investors, however, are waiting for additional evidence that DuPont has found the right blend of businesses to produce a new generation of lucrative products and sustained growth. Wee covers financial markets for BusinessWeek Online in New York